One Thing To Consider Before Buying Polo Resources Limited (LON:POL)

Simply Wall St
January 16, 2018

If you are looking to invest in Polo Resources Limited’s (AIM:POL), or currently own the stock, then you need to understand its beta in order to understand how it can affect the risk of your portfolio. There are two types of risks that affect the market value of a listed company such as POL. The first risk to consider is company-specific, which can be diversified away when you invest in other companies in the same industry as POL, because it is rare that an entire industry collapses at once. The second type is market risk, one that you cannot diversify away, since it arises from macroeconomic factors which directly affects all the stocks in the market.

Not every stock is exposed to the same level of market risk. A widely-used metric to measure a stock’s market risk is beta, and the broad market index represents a beta value of one. Any stock with a beta of greater than one is considered more volatile than the market, and those with a beta less than one is generally less volatile.

An interpretation of POL’s beta

Polo Resources’s beta of 0.24 indicates that the stock value will be less variable compared to the whole stock market. This means that the change in POL’s value, whether it goes up or down, will be of a smaller degree than the change in value of the entire stock market index. POL’s beta indicates it is a stock that investors may find valuable if they want to reduce the overall market risk exposure of their stock portfolio. AIM:POL Income Statement Jan 16th 18

How does POL’s size and industry impact its risk?

POL, with its market capitalisation of £16.60M, is a small-cap stock, which generally have higher beta than similar companies of larger size. Moreover, POL’s industry, oil and gas, is considered to be cyclical, which means it is more volatile than the market over the economic cycle. Therefore, investors may expect high beta associated with small companies, as well as those operating in the oil and gas industry, relative to those more well-established firms in a more defensive industry. It seems as though there is an inconsistency in risks portrayed by POL’s size and industry relative to its actual beta value. A potential driver of this variance can be a fundamental factor, which we will take a look at next.

Can POL’s asset-composition point to a higher beta?

During times of economic downturn, low demand may cause companies to readjust production of their goods and services. It is more difficult for companies to lower their cost, if the majority of these costs are generated by fixed assets. Therefore, this is a type of risk which is associated with higher beta. I examine POL’s ratio of fixed assets to total assets to see whether the company is highly exposed to the risk of this type of constraint. Given that fixed assets make up less than a third of the company’s total assets, POL doesn’t rely heavily upon these expensive, inflexible assets to run its business during downturns. Thus, we can expect POL to be more stable in the face of market movements, relative to its peers of similar size but with a higher portion of fixed assets on their books. Similarly, POL’s beta value conveys the same message.

What this means for you:

You could benefit from lower risk during times of economic decline by holding onto POL. Its low fixed cost also means that, in terms of operating leverage, it is relatively flexible during times of economic downturns. In order to fully understand whether XYZ is a good investment for you, we also need to consider important company-specific fundamentals such as Polo Resources’s financial health and performance track record. I highly recommend you to complete your research by taking a look at the following:

1. Financial Health: Is POL’s operations financially sustainable? Balance sheets can be hard to analyze, which is why we’ve done it for you. Check out our financial health checks here.

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